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Beware the Nano Lawyers

By Jack Uldrich
August 8, 2006

Through 2005, the number of nanotechnology patents issued increased to a total of almost 5,000 -- up from 1,300 just five years earlier. Surprisingly, the number of nanotechnology-related lawsuits did not keep pace. Three recent events, however, suggest that the dam might be about to burst. If they're not careful, investors could get caught in the deluge.

There's a simple explanation for why nanotech's lawsuit-free days are coming to an end: The technology is now making companies real money. From a business perspective, it now makes sense for the holders of certain nanotech patents to send in their army of lawyers, because they might be able to encourage would-be competitors to either agree to potentially lucrative licensing agreements or, alternatively, force them out of a promising market.

Big markets at stake
Last week, I wrote about NVE's (Nasdaq: NVEC) recent price run-up, suggesting that it could be attributed to the company's technology being employed in a new hearing-aid device. While this explanation still holds water, an equally plausible explanation could be found in recent comments made by NVE's CEO, Dan Baker, who suggested in a recent press conference that he felt that Freescale Semiconductor's (Nasdaq: FSL) new MRAM device had "come within the scope of claims in a number of NVE's patents." (MRAM is similar to flash memory, but it holds on to its data even when the device is off. MRAM's advent suggests that "always on" computers are a distinct possibility in the not-so-distant future.)

For NVE, it only makes economic sense to contemplate a lawsuit because the market for MRAM has been estimated to be as high as $50 billion. Even a small slice of such a sizeable market could result in a big payoff for NVE and its investors.

A similar story is now playing out between Elan (NYSE: ELN) and Abraxis Biosciences (Nasdaq: ABBI) over a proprietary nanoparticle technology that has led to $134 million in sales of Abraxane, Abraxis' breast-cancer treatment.

The tip of the iceberg...
Elan's lawsuit and NVE's potential lawsuit are only the tip of the proverbial iceberg. Last Friday, Tokyo-based NEC, whose researcher Sumio Iijima discovered carbon nanotubes back in 1991, announced that it had come to terms on a patenting licensing agreement with SouthWest Nanotechnologies, a private manufacturer of carbon nanotubes.

The deal makes good on NEC's announcement in 2005 that it would aggressively enforce its carbon nanotube patents. This is important, because scores of companies, including IBM (NYSE: IBM), have also filed patents on carbon nanotubes -- and these patents cover everything from single-walled and multiwalled nanotubes to using carbon nanotubes as drug-delivery devices.

Sorting out these competing patents claims will be no easy task, because of two related factors: overlapping and overly broad patents.

Both problems have been exacerbated by a serious shortage of patent examiners trained in the nanosciences at the United States Patent and Trade Office (USPTO). In essence, because of the field's complexity, patents covering the same space have been issued. This lack of knowledge has also caused patent examiners to issue overly broad patents. In one of the more egregious examples, IBM was awarded a patent for single-walled nanotubes, which "Big Blue" defined as "a hollow carbon fiber having a wall consisting of a single layer of carbon atoms."

To the untrained eye, the definition might seem descriptive, but to an army of highly paid, well-trained lawyers, the definition is so vague that they and their law firms can drive a cash-filled armored car around, over, and through it.

... and the ships in its path
Because carbon nanotubes are a core material for nanotechnology and they have a bevy of applications, these overlapping and ill-defined patents could snare a number of companies -- and their investors -- in numerous costly lawsuits.

For instance, IBM is well down the road in employing carbon nanotubes in next-generation transistors. Motorola (NYSE: MOT) is employing carbon nanotubes to construct flat-panel displays. Plug Power is experimenting with them to improve the effectiveness of fuel-cell membranes, and DuPont and others intend to use them in a variety of coatings. Carbon nanotubes are so useful, in fact, that they're being used for applications as broad as water desalination, bike frames, and NASA space craft.

The problem, however, transcends these nanotubes. Invitrogen (Nasdaq: IVTN) is using quantum dots for diagnostic applications, BASF (NYSE: BF) is utilizing new nanomaterials, and SurroMed is experimenting with nanoparticles as imaging agents. A number of other patents have also been filed in the areas of dendrimers, fullerenes, aerogels, and nanowires. (Don't worry, there won't be a quiz on this.)

As soon as any of these applications begin making money, some company will inevitably claim that its intellectual property has been infringed. These claims may or may not be valid, but because the stakes will be so high, there is often little downside to the filer of the lawsuit.

This unfortunate reality will only grow more pronounced in the years ahead. In addition to the money at stake, according to leading nanotechnology research firm Lux Research, there is a growing bottleneck of nanotechnology patents pending at the USPTO. It now takes nearly four years between the average filing and issuance of a nanotech patent. As these patents work their way out of the system, more lawsuits are likely.

What should individual investors do?
First, investors must recognize that the legal playing field is not equal. Smaller companies such as NVE may be at a competitive disadvantage against their larger competitors. They often lack the financial resources and the time to compete against bigger firms' deep pockets. The larger companies, because of their diversity, can easily survive as the lawsuits drag out for years. Smaller companies may find their resources dwindling far more quickly.

One potential strategy is for smaller companies to partner with larger companies, as Dendritic Nanotechnologies has with Dow Chemical (NYSE: DOW) in the field of dendrimers.

I'd also encourage investors to consider the strength of a company's intellectual property (IP) portfolio. This can be a time-consuming task, but investors can make some educated guesses. For instance, because of its resources and its rich history, IBM's IP portfolio should be relatively strong.

Similarly, it's worth considering which companies are making strategic moves to bolster their IP positions. Last year, Invitrogen acquired Quantum Dot Corporation and all of its IP; while Arrowhead Research (Nasdaq: ARWR) has publicly stated that a large part of its business plan is to acquire the most promising IP coming out of universities around the country.

Be careful out there
Lawsuits are a reality, and sometimes bad lawsuits hurt good people. The field of nanotechnology will begin experiencing increasing numbers of players, and the best thing you can do is keep your eyes open to the possibility of costly legal wrangling -- and stay away from smaller companies hanging out in overcrowded neighborhoods where the big boys are playing.

Think small with further nanoscale Foolishness:

The Motley Fool Rule Breakers newsletter has its very own nanotech/new-tech column each month, as well as two monthly stock recommendations. Try it free for 30 days.

Fool contributor Jack Uldrich is the author of two books on nanotechnology, including Investing in Nanotechnology: Think Small, Win Big. He owns stock in Elan, Freescale, and IBM. Dow Chemical is a Motley Fool Income Investor pick. The Fool has a disclosure policy.